Explain the Concept of Depreciation

by Kristen May - Updated September 26, 2017

When running a business, depreciation gives a more accurate picture of the financial state of the business by listing assets' loss of value as an expense. That way, the initial cost of an item is divided over its useful life.

Identification

Items that depreciate are assets used over a number of years that have a lower resale value after each year of use. Examples include vehicles, machinery, buildings and furniture. Land does not depreciate.

Accounting

Depreciation is listed as an expense in the accounting of a business. Doing this can more accurately measure profits as that item assists in the business during each year.

Video of the Day

Annual Depreciation

The annual depreciation of an asset is a portion of its original cost. Straight-line depreciation subtracts the resale value from the purchase price and divides that by the number of years the item is expected to be used. Other depreciation methods have the item depreciate more quickly in the first few years and more slowly thereafter.

Tax Implications

Depreciation can be an income tax deduction for items used in business. The Internal Revenue Service has strict guidelines on eligible items and conditions for deducting depreciation.

Currency

The other realm in which depreciation applies is in currency exchange, where a particular currency depreciates when it loses value in comparison to other currencies.